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ESG has skyrocketed to the top of many PE firms’ list of strategic priorities in the past couple of years. PE firms that may have historically viewed ESG as a “nice to have” or a “check the box” exercise, are now increasingly considering ESG to be a business issue that is embedded in the business, not peripheral to it.
PE firms such as KKR that were early adopters of and believers in ESG are now in a position not only to lead the charge to net zero, but to share their learnings with other firms that may be earlier on their ESG journey. At KKR, ESG is viewed as a way to both protect and enhance value over time and is managed alongside other business issues.
KKR is focused on climate change, data and integrating ESG issues and subject matter expertise into the investment process. The firm views ESG data not as a way to score potential targets, but to identify a pathway to managing ESG-related risk sover the duration of the hold period. Lastly, KKR has identified three measurable ESG pillars across the portfolio regardless of industry: climate, human capital and data responsibility (cybersecurity and data privacy).
Key takeaways:
PE has an interesting role to play in the transition to net zero, and firms are likely to focus on 6 key areas:
Creating and protecting value through ESG
Building and deploying teams of resources and expertise
Integrating climate and ESG cosiderations into investment processes
Launching standalone ESG or impact funds
Spotlighting portfolio companies that are addressing critical environmental and social challenges
Collaborating and knowledge sharing to share solutions and best practices
For your convenience, full text transcript of this podcast is also available.
Winna Brown
You’re listening to the EY NextWave Private Equity podcast. I’m Winna Brown, and I’m your host. ESG, over the past couple of years, has skyrocketed to the top of many PE firms’ lists of strategic priorities. PE firms that may have historically viewed ESG as a “nice-to-have” or a “check-the-box” exercise are now increasingly considering ESG to be a business issue that’s embedded in the business and not peripheral to it. PE firms that were early adopters of and believers in ESG are now in a position to not only lead the charge to net zero, but to share their learnings with other firms that may be earlier on their ESG journey. KKR is one such firm that was an early adopter of ESG. I’m so pleased today to be speaking with Elizabeth Seeger, Managing Director of Sustainable Investing at KKR. Elizabeth joined KKR in 2009 to help oversee the consideration of ESG issues throughout KKR’s investment process, including the management of KKR’s ESG-focused value-creation programs for its portfolio companies. She is also a member of KKR’s Global Impact team. In today’s episode, we’ll discuss the firm’s mindset around ESG and explore their focus, both on value creation and value protection through the integration of, and embedding of, ESG in every aspect of their business and portfolio.
So, Elizabeth, KKR is undeniably a leader and visionary when it comes to ESG. Can you share a bit about KKR’s history in the space and their ESG philosophy at both a firm and a portfolio level?
Elizabeth Seeger
Yeah. Sure. And first of all, thank you for the kind words. In fact, a number of our peers are really focused on ESG broadly and climate change specifically these days, but we have been focused on this work for a really long time. And, you know, where it started for KKR is really where we’re focused today, which is that we think that by thoughtfully focusing on ESG issues, we can both protect and enhance value. When we partnered with EDF to work with KKR portfolio companies to help drive both environmental performance and business performance at the same time, it’s really that model that we’ve continued to replicate over time as we’ve grown the work that we’re doing. And I would say just one more thing on that, you know, in addition to believing that ESG issues can be material to the value of a company over time, I think the private equity model, in particular, serves as a really important and useful platform for active engagement on these topics over a relatively long time period. So, we’ve really been focusing on how do we partner with our companies over the long term on these issues to support the efforts over time to help drive value.
Brown
So which aspects of ESG are currently top of mind for your various stakeholders? So, your LPs, your employees, from leadership, and to what extent has their attention to and prioritization of ESG changed since the COVID-19 pandemic?
Seeger
Well, I’ll start with answering the second, or the last part of your question first around what has changed since the COVID-19 pandemic. In fact, I remember in late 2019, a moment where I thought, wow, things are changing, and things are going to change really quickly now. So, in fact, while I think the pandemic brought to light a number of issues that we all really need to focus on, we were well on our way as it related to momentum before the pandemic even came, and we saw a lot of that really, really come to light then during the pandemic and now today, as well. But there are a number of things I wake up every single day thinking about and so I’ll name a few of those because I think they certainly reflect the interests of our various stakeholders as well.
The first is, you know, not just in private equity, but across KKR’s asset classes, how do we make sure we are in a best-in-class way integrating the consideration of ESG issues into our investment processes, that is private equity, credit, real estate, infrastructure, you know, easier said than done in many ways because the bar is moving all the time. The issues continue to evolve in our portfolio companies and our portfolios are getting more complex and larger all the time as well. So that’s something that we’re spending a lot of time making sure that we are being thoughtful and building the resources needed to do that.
The second one, just like everybody else, really focuses on climate change and private equity, in particular, has a really interesting role to play as it relates to the transition and moving companies along the various pathways.
And then third, and one I could speak about all day and oftentimes do is data, ESG data. And I know this is really important to the EY team as well. There are a lot of ways that you can get this wrong, but how do we really measure and evaluate performance over time? Particularly if you’re working with companies that may not already have the capabilities to do this kind of work already. And then how do we, you know, once we have thousands of different data points, make sure we’re evaluating and driving insight in a way that’s scalable over time as well? So, a lot of work that we’re doing to invest in this particular area as well.
Brown
That’s really great insight, Elizabeth, thank you. And, as I think about the change that needs to happen as we all embark on ESG, the tone from the top is always critical. Embedding, however, an ESG focus on a private equity setting is actually really complex because you need to consider, as you mentioned, the firm level, you need to consider your deal teams, and you need to consider each of the portfolio companies. Each of them operates in different sectors, they’re different sizes, they have different materiality or material ESG factors to consider, and they actually operate as stand-alone businesses. So, there are so many challenges wrapped up in this journey. So how have you been able to navigate these challenges at KKR? And maybe you could offer some advice to other PE firms who are perhaps a little bit earlier on this journey and are looking to start.
Seeger
Yeah, sure. And first, yes, very complex, and I often say, you know, one of the things that have kept me at KKR so long is that every single day is different. And, you know, when you’re working across hundreds of different companies and different asset classes, you have hundreds of different issues and different sorts of intellectual challenges, if you will. So, it’s really very different from day to day. I’ll answer with two thoughts.
One is, we have a number of examples at KKR where we have what I would call groups of subject-matter experts within the organization, such as KKR Global Institute, the KKR Global Macro team, and I see the ESG resources at KKR as another sort of internal source of subject-matter expertise. Ultimately, really, and particularly in a large and growing organization, it’s really critical that the investment teams and the people making the decisions on the ground are really accountable for and enabled to make the decisions as it relates to ESG topics over time. So, it’s really about making sure that they have the tools and resources and guidance that they need, and the access to subject-matter expertise to really, really drive performance over time. So that’s really what we’re focused on.
The second is that subject-matter expertise and how we think about it. And so, in the past year between Q1 of 2021 and Q1 of 2022, we tripled the size of the internal ESG resources at KKR. Now, we’re at 15 people who are 100% dedicated, every single day, to thinking about sustainability and ESG work across KKR, but that looks very different from person to person. So, for example, we hired KKR’s first ESG Compliance Officer, think it’s the first in the industry, who is 100% focused on making sure that we have the controls and procedures in place at KKR, to think about how are we complying with not only the things that we say but also the different relevant regulatory schemes. And then the most recent person that we hired is the ESG data analyst, who actually sits in the finance team, but whose role is really to think 100% about ESG data every single day. And then the others on the team are really tagged to each of the different strategies within KKR to make sure that the different strategies, like real estate, credit, infrastructure, private equity, are getting the resources that they need in a way that’s relevant to them as well.
Brown
That’s brilliant. Congratulations. Sounds like your team is just growing at an amazing rate and just really focused on the right areas to move forward, which is, which is really exciting. If we could then maybe just pivot a little bit though to deals, and perhaps you can help us understand how your team is supporting the acquisitions that are being made by KKR. And, I mean, of course, it’s, you know, no secret, you know, identifying rate targets and closing deals on investments is really just the lifeblood of private equity firms. So, how are you incorporating or thinking about a dedicated ESG due diligence when, when you’re evaluating investments? And what does your analysis kind of focus on? Are there specific areas that you hone in on, or is it really target-dependent?
Seeger
It’s a great question because you’re right, it is the lifeblood. It is really an important part of what KKR does. What I often say is, that ESG issues are business issues and therefore should be managed as business issues. And so, what does that mean in practice? It means two things. One is that we take a materiality-driven approach, and we’re going to be looking at what’s relevant for a particular company based on its industry, its stakeholders, and where it operates. And here, we do use the Sustainability Accounting Standards Board, or SASB standards, as a primary input for thinking about what’s going to be relevant for a particular company based on its industry.
And the second thing that means is we want to take an integrated approach to how we think about ESG topics. So, if you believe that ESG issues are business issues or can be business issues, you want them to be considered alongside when other business issues are being evaluated and managed over time. So, in fact, you know, we aren’t trying to build a separate process. It’s not as if we’re outsourcing the analytics to a different team somewhere else in the organization. It’s really important, like I said earlier, to make sure that we are supporting the teams as they’re doing this work in the moments when they’re making these decisions.
Brown
Elizabeth, how relevant is a target’s ESG score to your investment decisions? So, in other words, are you selecting for or against companies based on their ESG profile? And perhaps share with us what’s a literal deal-breaker for you.
Seeger
In the private equity context, what we’re really looking at is to make sure that we’re understanding the business-relevant risks and opportunities in a way that we have really a been a pathway for how we’re going to manage that risk or opportunity during the life of our investment. So, in terms of red flags, what that looks like in the private equity context could be very different than what it looks like in a credit context, where we don’t necessarily have the influence to partner with a company over the long term on that issue. So, in private equity, what we’re really trying to do is understand: What is the potential risk? Do we have a way, as KKR, to make sure that we feel comfortable either with how the company is managing it or how we’re going to help them manage it over time? And if not, then we feel like there’s probably a risk to the investment or to KKR that makes it unsuitable for investment. But, really our goal in the diligence process is not to screen companies out because of that, but really to make sure that we understand the plan going forward, and maybe we even have a differentiated way to create value by focusing on this topic and supporting the company and improving on it as well.
Brown
It’s less about risk mitigation but all about value creation.
Seeger
Yeah, that’s right. As investors, we bring something to the table, and it’s part of our investment thesis in many cases to help companies really manage these things thoughtfully.
Brown
So, can you share with us whether you are deploying and measuring against a set baseline of ESG KPIs consistently across your portfolio? And, if so, what are you actually measuring now? And what do you aspire to measure in the future?
Seeger
I’ll start by saying the most important source of information in our private equity strategy is the ongoing engagement we have with the boards of directors and the management teams right. That’s number one, right? That’s where we’re focusing on, those material topics. How the company is managing it. How we can support them over time. That said, due to expectations and needs from our different stakeholders, such as our fund investors, as well as different regulators, we are also collecting, you know, various KPIs across the portfolio so that we can be responsive to those needs. And those sorts of things include carbon emissions; diversity, equity inclusion metrics; and a number of other things that different regulators in LPs might be focused on as well. And we use that data in a number of different ways including helping us understand where we might want to build additional resources to support companies across the portfolio. So, for example, in 2020 and 2021, we had a climate action webinar series to help companies understand what are Scopes 1, 2, and 3 emissions? How do we measure it? What’s best in class on that? What is climate risk? What is the TCFD? How do we respond to it? And are in the process right now of refreshing a number of our resources based on input that we’ve gotten from companies, based on showing us exactly where some of the areas for improvement are. So, a lot of ways that we use the data, for sure, and obviously a moving target as well as different expectations, as the expectations change or grow over time as well. We do believe that there are three cross-portfolio topics that are really important in many cases, regardless of the industry or though it may show up in different ways in the different industries, and those are climate, human capital, and what we call data responsibility, which is cybersecurity and data privacy. So, in addition to that industry- or company-relevant issues, we are really focusing a lot of our attention and resources on those three cross-portfolio topics as well.
Brown
Yeah, those are definitely three areas that it doesn’t matter what sector you’re in, they really are top of mind, even if they’re not the most material risk for your sector, your investors and your shareholders, and your, the consumers of those products all want to know where they are in the journey. So, it kind of transcends any kind of materiality.
Seeger
Yeah, that’s exactly right. And we feel there’s a real opportunity, particularly in private equity, to support the companies on that and provide guidance as they move on to the next stage of their journey on those topics.
Brown
Yeah. So, Elizabeth, I mean, as we know, all portfolio companies are eventually destined to be exited. To what degree does KKR think about value creation through ESG as part of the portfolio company’s equity story and really bringing to life value.
Seeger
Yeah, sure. And it really comes back to what I’ve been talking about, which is taking a materiality-driven approach. So, the issues that will be relevant to a company over time and then that will drive value at exit are going to be specific to that company and how it’s managing it. So, you know, this is really a continuation of the story that starts at diligence when we’re looking at what are the business-relevant risks and opportunities and how can we partner with companies on that over time. I think one example of something that’s coming up quite a bit these days is, as it relates to climate though, so one of those cross-portfolio topics, and a growing understanding that when, as private equity investors, we are exiting these companies in three to five years, or whatever the case may be, the environment as it relates to investing around climate solutions, as well as climate transition, will be in a different place then than it is today. So how do we think about where investors, and maybe strategic buyers, will be in three to five years is really important to how we think about partnering with the companies on this particular topic today as well.
Brown
That makes a lot of sense. But also, it takes a lot of forward-looking thinking, and hence the fact that you’ve been building your team with all these different cross skillsets to help you kind of imagine what’s the world going to look like, what are investors going to value, how do we position and pivot? It’s just part of the whole unknown and exciting journey that we’re all part of.
Seeger
It is. It is. And I would say, you know, climate, in particular, is a really interesting example of an issue that is cross-functional in nature. So, it’s not as if one team within an organization can really manage the issue and that’s it, right? This is done at KKR in partnership with the KKR Global Macro team, with a KKR Global Institute, with KKR Capstone, which is our operational implementation experts at KKR. So it’s really work that’s happening across the organization and really needs to happen, bringing everybody along on it as well.
Brown
Clearly, there were a lot of eyes on COP26; however, to date, there have really only been a handful of private equity firms that have made public commitments to net zero. Do you think given the complexity of private equity; the sector just really needs some time to get the foundations right before making broad public commitments?
Seeger
I think there are probably a couple of things going on here. One is that prior to late last year, there was no guidance as it relates to private equity and net zero, right? And so, the guidance and the different pathways for how private equity might think about a commitment like this are still relatively new and are being tested right now. So, I think a lot of us are trying to understand what that looks like and the implications for us as well. The second thing I’ll say, and I think this is really important, is that we believe that private equity has a really important and key role to play as it relates to the transition. So, we’re investing in these companies for multiple years at a time. When we enter into or exit a company, it can have a pretty significant impact on the carbon profile of a particular fund. We’re not just divesting companies because they are high carbon intensity. We are really working with the companies’ overtime to put them on the pathway for, for their transition. And in fact, we have three funds at KKR that are half committed to a net zero pathway for the companies in which we are majority owners, and we’re working with those companies to make sure that they put in place decarbonization plans aligned with net zero by 2050 within the first two years of, of our investment. But that’s a very different strategy than an investor who might be balancing their portfolio by investing in or exiting companies solely based on carbon intensity alone.
Brown
So, Elizabeth, I don’t know about you, but I feel like there’s been an accelerated focus on ESG by private equity over the last six months. Where do you see the sector going? Do you think there’s going to be more formal, sweeping, enterprise-wide public commitments being made, or will firms instead focus on a combination of specific targeted strategies and perhaps launch dedicated ESG funds?
Seeger
I think we should expect all of the above. In fact, I know that myself and my peers, we’re all working on these topics right now. All of us are team building, and resource building, all of us are participating in the same conversations, and all of us bring different things to the table as well, right. So, for KKR, we’re really focused on making sure that we’re integrating ESG considerations and climate considerations in our investment process, but we also have our stand-alone Global Impact Fund, which is investing across multiple sustainable investment categories, such as climate action, sustainable living, inclusive growth, and lifelong learning. So again, I think there is sort of all of the above happening across the industry, and we are certainly getting together and sharing best practices and frameworks to the extent we can as well. So hopefully we’ll see a lot of convergence as it relates to how we’re talking about these topics over time.
Brown
So Elizabeth, having just heard what you’ve said, as we look ahead to COP27, I’m really interested in understanding your view on whether history is going to look back and note it as this pivotal moment for climate change. So, the moment when the global private equity sector came together in a united way and was focused on achieving net zero, or is it going to be another conference where we do a lot of discussions, a lot of exchange of information, but maybe not much-committed action that follows?
Seeger
I am truly bad at making predictions about anything, trust me on that. But I’ll say this, I have never seen this much momentum on a particular topic in my 20+ years of being in the sustainability world. And I’ve seen more momentum and the past six months than the past two years combined, and the past 20 years combined. So, I am optimistic that, you know, things are changing now in ways that they weren’t changing before. So, we’ll see. I’ll let others make predictions on that, but I am seeing like I said, signs or leading indicators that we’ll probably be having a different discussion in the coming year.
Brown
Excellent. Like you, I think that’s been my observation. The last six months have been this urgency that we have not seen before, so I’ve got my fingers and toes crossed. Okay. So, as we round off our discussion, Elizabeth, KKR is seen as an ESG leader in the private equity sector. They’re a firm that many look to for inspiration on how to embed ESG strategies within either the top of the house, the deals or, you know, the portfolio companies. How do you see KKR’s role as an ESG leader evolve into the future?
Seeger
Thank you for that question. I have been at KKR since 2009, and I often say, every single year I couldn’t have imagined we’d be here today. But I think what’s really important for KKR is that we’ve always really stuck to this focus on value creation and value protection, and we’ll continue to do that. And I think this is particularly important today, as we see a lot of people jumping into the space, this ESG space, if you want to call it that, and we want to make sure that we’re not falling into the habit of box-checking, or I’ve heard ESG by the numbers. It’s really important that we continue to manage these issues in thinking about how we both protect and enhance value within KKR portfolio companies, and we’ll continue to be at the table also, making sure that we’re continuing along with the industry collaborations to share best practices and share challenges and find collective solutions to those as well.
Brown
Well, thank you, Elizabeth. I think exactly as you said: by keeping a focus on ESG as a value creator and as a business issue that needs to be tackled and it’s not check-the-box, means that you’re going to continue as KKR being at the forefront, leading the charge.
